College Savings with a 529 Plan
May 29th is National 529 Day. This week Nichole Coyle, CERTIFIED FINANCIAL PLANNER™, talks about what a 529 plan is and recent changes that have made this education investment vehicle even more attractive.
A 529 plan is a college savings account that allows you to save money for your child’s (or other family member’s) college education. The account’s earnings grow tax-free, AND they are not taxed when they’re withdrawn as long as they are used for qualified education expenses. That means that no matter how much your money grows in a 529 plan, you’ll never have to pay taxes on it as long as the funds are used for education purposes.
Some benefits of 529 plans include:
Additional tax benefits
Certain states sponsor 529 plans and allow you to deduct some of the contributions from your state income tax. In Ohio, for example, you can deduct up to $4,000 per beneficiary per year with their sponsored plan. The amount has an unlimited carry-forward which means that the $4,000 is not an annual cap. In Ohio, you can contribute more than $4,000 in one year, then subtract $4,000 per year from your State of Ohio taxable income until all of your plan contributions have been deducted.
You, as the owner, have control of the funds
The beneficiary (likely your child) does not have control of the money inside the plan. This is a big benefit because you can make sure the money is used for its intended purpose. This also means that there is a lesser implication for financial aid purposes because the funds are counted as the parent’s and not the child’s asset.
There are no income limits
A 529 plan does not have income limits. Regardless of how much money you make, you can continue to contribute to these plans. There are, however, some limits on how much you can contribute each year. If you put more than $17,000 (in 2023) into a 529 plan for someone, you may have to pay gift tax on the contribution. If you are married, both you and your spouse can EACH contribute up to $17,000 for each beneficiary, totaling $34,000 per year per beneficiary.
You can start saving now! (even if you don’t have a kid)
You don’t have to wait until your child is born to start saving money for their education. You can start a 529 plan, list yourself as the beneficiary, and then change the beneficiary to your child once they’re born.
It can work as a backdoor ROTH IRA for your child
Beginning in 2024 you will be able to convert the leftover balance (up to $35,000) into a Roth IRA for your child. The funds must be in the 529 plan for at least 15 years before converting to a Roth. However, most 529 plans are established years before a child reaches college age, so the 15-year maturity within the plan likely won’t cause many issues. This could be a great way to jumpstart your child’s tax-free retirement savings in the event they don’t need to use their full account balance towards education.
Drawbacks of 529 Plans worth considering:
529 plans factor into financial aid calculations
Colleges consider 529 money when determining financial aid awards. Accumulated money in these accounts is included in the parent’s assets that contribute towards a child’s EFC (Expected Family Contribution). However, only 5.64% of a parent’s allowable assets are used in the calculation of EFC as compared to 20% of the child’s assets. This means that your child could receive less financial aid for having money in a 529 plan, but it’s a lesser impact than having the funds in a savings or investment account in the child’s name.
There are penalties for non-education use
If you choose to withdraw money from a 529 account and use it for something other than its intended purpose (or do not convert to a Roth IRA), you will pay regular federal tax as well as a 10% penalty tax on the earnings. However, if the beneficiary gets a scholarship to college, the penalty for withdrawing and not using it for education expenses is waived.
Accounts are subject to market risk
Many 529 plans are invested in vehicles similar to retirement accounts. This allows for long-term growth that can outpace inflation and potentially help with the rising costs of higher education. Investment accounts, while they have their advantages, also come with a certain amount of risk. So, if your child will be attending college in the next couple of years, a 529 plan may not be the best option for them. Talk with your financial advisor about your specific situation and find out if a 529 plan is right for you.
Conclusions
A 529 plan can be a good college savings plan for many families looking to save for school. Talk with a trusted financial advisor and consider the pros and cons of each option you have.
As always, if you have questions regarding 529 Plans or any other financial matter, please don’t hesitate to contact me!
Nichole M. Coyle
CERTIFIED FINANCIAL PLANNER™
20333 Emerald Pkwy
Cleveland, OH 44135
216.621.4644 x1607
Securities and advisory services offered through Cetera Advisor Networks LLC, member FINRA/SIPC, a Broker-Dealer, and a Registered Investment Advisor.
Cetera is not affiliated with the financial institution where investment services are offered or any other named entity.
Investments are: Not FDIC/NCUSIF insured * May lose value * Not financial institution guaranteed * Not a deposit * Not insured by a federal government agency.
Investors should consider the investment objectives, risks, charges, and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing.
Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investing in any state’s 529 Plan.
Converting a Traditional IRA to a Roth IRA is a taxable event.
A Roth IRA offers tax-free withdrawals on taxable contributions.
To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five years, and the distribution must take place after 59 1/2 or due to death, disability, or a first-time home purchase (up to $10,000 lifetime maximum). Depending on the state law, Roth IRA distributions may be subject to state taxes.
Posted In: Guest Blog, Saving
